Regulatory Impact Statement

GST Current Issues

Agency Disclosure Statement

This Regulatory Impact Statement (RIS) has been prepared by Inland Revenue.

It provides an analysis of options to address four GST-related items. The issues arise in situations where the technical requirements of the Goods and Services Tax Act 1985 result in high compliance costs for businesses, do not match commercial practice, or do not reach the right policy outcome.

Four items are considered in this RIS. They are:

  • The deductibility of GST incurred in raising capital to fund a taxable business activity
  • Compliance costs experienced in determining the proportion of GST that can be deducted
  • The ability to recover GST embedded in secondhand goods composed of gold
  • The treatment of services closely connected with land

A key gap in the analysis of the issues is the information around the size and scale of the items. Information from public sources, provided by submitters, or held by Inland Revenue, has been used to estimate these impacts as far as possible, but in many cases it is incomplete or anecdotal. This has also made it difficult to quantify the impacts.

Submissions received during public consultation on these items and analysis generally agreed with officials’ views on the size and scale of the underlying issue. Submitters included professional firms and industry associations, who may be expected to have a good overview of a number of businesses that may be affected by the proposed regulation.

Where there is not sufficient information to quantify the impacts, this bas been noted in the RIS.

Inland Revenue has consulted the Treasury in relation to all four items. The Ministry of Business, Innovation and Employment was consulted in relation to the capital raising proposal. Both agencies were supportive of officials’ preferred solutions.

The items were also publicly consulted on through an officials’ issues paper, GST Current Issues, released on 17 September 2015. Submitters supported officials preferred solution to the first three items. Submitters did not support officials’ preferred solution for the fourth item relating to the treatment of services closely connected with land. The feedback received has been taken into account in developing options and in the analysis contained in this RIS.

None of the policy options would impose additional costs on businesses, impair private property rights, restrict market competition, reduce the incentives for businesses to innovate and invest, or override fundamental common law principles.

Marie Pallot

Policy Manager, Policy and Strategy

Inland Revenue

11 February 2016


INTRODUCTION

1.This Regulatory Impact Statement considers four GST-related items. Although each itemis separate, they all occur within the policy framework of GST and the legislative requirements, found in the Goods and Services Tax Act 1985 (the “GST Act”), that give effect to this policy.

2.These itemswere the subject of public consultation (in the officials’ issues paper GST Current Issues which was released on 17 September 2015). 14 submissions were received. Most submitters were industry associations or professional firms.

3.The items were:

  • To enable businesses to recover GST on costs incurred to raise capital to fund their taxable business activities;
  • To address high compliance costs experienced by large, partially exempt, businesses (such as retirement villages) in calculating the GST they can recover;
  • To enable businesses acquiring secondhand goods composed of gold, silver or platinum to claim deductions for embedded GST; and
  • To amend the tests for when services closely connected with land are treated as consumed in New Zealand, and therefore subject to GST, with the international approach.

4.Analysis of each item follows the following format:

  • Status quo and problem definition
  • Key objectives for the item
  • Regulatory impact analysis – assessment against the stated objectives
  • Consultation – how feedback from consultation shaped the analysis of the item
  • Conclusion – officials preferred option

GST policy and law

5.Goods and Services Tax (GST) is a tax on consumption. GST is imposed according to the destination principle – that is, that goods and services should be taxed in the jurisdiction in which they are consumed. This results in most supplies of goods and services in New Zealand, as well as imports, being charged with GST. Conversely, exports are not charged with GST.

Consistently with New Zealand’s general tax policy settings, GST is imposed at a single rate (15%), across a broad base of goods and services. This broad-based single-rate approachis intended to distort suppliers’, and purchasers’ preferences as little as possible.

Tax on consumption

6.Although GST is a tax on consumption, it is imposed on all supplies and not just supplies to consumers. To ensure that GST does not accumulate at each step of a supply chain, businesses are able to recover the GST incurred on goods or services they purchase (via “input tax deductions”), where they use those goods and services to make taxable supplies. Input tax deductions are set off against the amount of GST that the business is required to pay on their own supplies of goods and services. If input tax deductions exceed the tax to pay, they are refunded to the business. This “credit-invoice” mechanism ensures that GST is not a cost to business, and is only imposed once on consumption.

7.An exception to this approach exists for some supplies (exempt supplies) which are not taxed when supplied by the business and are instead taxed by preventing the business making the exempt supply from claiming input tax deductions. This option typically will not tax the full value of consumption and is therefore the second-best option from a theoretical point of view. In practice it is used where difficulties valuing the consumption or other practical considerations mean that taxing the consumption is not feasible and input tax deduction denial is the best practical option.

8.Input tax deductions are also allowed for secondhand goods acquired by a business, from a person who does not charge GST on that supply (for example, because they are a consumer). Although the supplier does not charge GST, they will have incurred GST when they purchased the good, which they could not recover. The input tax deduction recognises the consumption of the goods has already been taxed, and that GST is implicitly embedded in the purchase price.

9.In the absence of this rule, secondhand goods could be subject to taxation multiple times – by being taxed when they are first supplied, and taxed again if they are later repurchased and resold by a GST-registered business. The secondhand goods input tax deduction ensures that only additional value added is taxed.

Consumption in New Zealand

10.Another key criterion for goods and services to be taxable is that they be consumed in New Zealand. A number of legislative rules apply to determine whether goods or services are consumed in New Zealand or outside New Zealand. In practice the residency and location of the recipient are used to determine whether services are consumed in New Zealand or not, as well as the nature of the service.

11.Services that are physically performed in New Zealand are generally subject to GST, as they are typically consumed in New Zealand. Under the new place of supply rules proposed in the Taxation (Residential Land Withholding Tax, GST on Online Services, and Student Loans) Bill, GST will also apply to “remote” services (where the supplier and purchaser are not required to be in the same place for the services to be performed) that are performed outside New Zealand, if they are supplied to a New Zealand-resident consumer.

12.In contrast, supplies of services to non-residents outside New Zealand will typically not be taxed. To give effect to this policy of not taxing exported services, the services may be “zero-rated”. The supplier is able to claim input tax deductions for the GST they incur in making the supply, but they will not be required to return GST. This ensures that, for registered businesses, the supply is not taxed, nor is there GST implicitly embedded in the price.

OBJECTIVES

13.Theoverarchinggoal is to ensure that GST continues to meet its policy objectives of being a broad-based tax on consumption in New Zealand.

14.Theobjectives against which the options for each itemare to be assessedare:

  • Neutrality: Taxation should seek to be neutral and equitable between forms of commerce. Business decisions should be motivated by economic rather than tax considerations. Taxpayers in similar situations carrying out similar transactions should be subject to similar levels of taxation.
  • Efficiency: Compliance costs for businesses and administrative costs for the tax authorities should be minimised as far as possible.
  • Certainty and simplicity:The tax rules should be clear and simple to understand so that taxpayers can anticipate the tax consequences in advance of a transaction, including knowing when, where, and how the tax is to be accounted.
  • Effectiveness and fairness: Taxation should produce the right amount of tax at the right time. The potential for tax evasion and avoidance should be minimised while keeping counteracting measures proportionate to risks involved.

Constraints

15.A key constraint and consideration in meeting these objectives is revenue and, in particular, the policy to tax supplies of goods or services as enshrined in the GST Act. This means that certain minimum compliance and administration costs will be incurred in meeting the obligations imposed under theAct and that most supplies will already be subject to a 15% tax based on their value (with an associated impact on efficiency and neutrality).

REGULATORY IMPACT ANALYSIS

16.The four items analysed in this RIS are:

A)The deductibility of GST on costs incurred to raise capital to further a taxable business activity (“Capital raising costs”– page 5 - 10);

B)The compliance costs incurred in applying the legislated approach to determining the amount of input tax deduction that can be claimed in respect of goods and services used to make both taxable and exempt supplies (“Apportionment rules” – page 10- 17);

C)The ability to claim input tax deductions for secondhand goods composed of gold, silver or platinum (“Secondhand goods and gold” – page 18- 25); and

D)The treatment of supplies of services that are connected with land (“Services connected with land” – page 25- 32).

Item A:Capital raising costs

Status quo and problem definition

17.Supplies of financial services are generally exempt supplies. Exempting financial services recognises the inherent difficulty in determining the value of the service, as the financial service provider may be compensated by a margin or spread (for example, on the interest charged for lending) rather than an explicit fee. As it is therefore difficult to determine the value of the financial service consumed, the supply is effectively taxed by denying input tax deductions.

18.There are some exceptions to this approach. Since 1 January 2005, supplies of financial services to GST-registered businesses that predominantly make taxable supplies can be zero-rated, allowing financial service providers to claim deductions for the GST incurred in making these supplies. This was intended to reduce the potential for tax cascades caused by the exempt treatment of financial services, where tax must either be absorbed or passed on by the business receiving the supplies.

19.Another exception is for financial services supplied to non-residents outside New Zealand. The services are zero-rated, as any consumption occurs offshore.

20.Similar concerns arise when businesses that primarily provide taxable goods and services incur costs in raising capital. As the provision of debt or equity securities is treated as an exempt supply of financial services, the GST costs incurred in making these supplies cannot be recovered. Examples of these costs may include NZX listing fees, legal fees and costs associated with preparing a product disclosure statement.

21.As GST is applied on a transactional basis, the ability to claim input tax deductions in respect of goods or services is based on the supplies those goods or services are used to make. As the goods or services are used to make exempt supplies of financial services, deductions are denied.

22.This produces the correct result where the financial services are being consumed by the recipient (for example, the services are consumer lending). However, where the financial services are provided to raise capital, there is a strong argument that these supplies are actually part of the business’ supply chain, and are not consumed by the providers of the capital. Denying deductions for these costs is said to lead to tax cascades, as a taxable business must either absorb the GST cost or pass the cost onto its customers, with GST being charged on this amount again in later stages of the supply chain. This is contrary to GST’s role as a tax on consumption, rather than on business.

23.This analysis does not apply to businesses that principally make supplies of financial services. As these businesses act as intermediaries between borrowers and lenders, it is more difficult to determine the extent borrowing relates to the general business activities and the extent it relates to specific supplies. Special rules exist to enable businesses to elect to zero-rate their business-to-business supplies of financial services. Financial service providers may also enter into an agreement with the Commissioner of Inland Revenue on a fair and reasonable method of apportioning their costs between their taxable and exempt supplies.

24.This analysis is constrained by the available information on capital raising activities. Information on new, publicly listed, equity and debt is published by the NZX. The information published in the annual metrics between 2011 and 2014 indicates approximately $7 billion of new, primary, and secondary and dual equity issued per annum, and $400-500 million of debt.

25.Information on private capital raising is less readily available, both as to the amount of capital raised, and the number of participants in the industry. Industry publications suggest that, in 2014, $200 million of new equity was raised within the venture capital industry. Information on private debt is not available.

Objectives

26.The key objective iseffectiveness and fairness. GST is intended to be a tax applied once on consumption only once so thatcascades do not occur. This is not the result when capital raising costs are not deductible, and are incurred by the business or passed on. Passing on the cost of this GST may result in a tax cascade, where the unrecoverable GST is embedded in the price paid for the supply, and the supply itself is taxed. Neutrality is also an important objective for this item.

Regulatory impact analysis

27.One policy option and the status quo were considered for addressing the policy problem and meeting the objectives.

  • Option 1: Allow a deduction for capital raising costs to the extent that a registered business makes taxable supplies as a proportion of their total supplies.
  • Option 2: Retain the status quo under which businesses cannot deduct GST costs incurred in raising capital

Option 1: Allowing a deduction for capital raising costs

28.This option would involve allowing a deduction for GST costs incurred when a registered business raises capital. Amending legislation mechanism would provide for registered businesses thatare raising capital in order to fund their taxable activity to calculate an amount that canbe deducted.

29.In particular, it would allow a GST-registered business, that does not principally make financial supplies, to claim an input tax deduction for GST costs incurred in the:

  • issue or allotment of a debt or equity security;
  • renewal or variation of such a security;
  • payment of interest, dividends, or an amount of principal in respect of such a security; and
  • provision of a guarantee of another person’s obligations under such a security (for example, to guarantee repayment of the principal advanced under a debt security).

30.The GST incurred in relation to these costs would be deductible to the extent that the taxpayer makes taxable supplies, as determined using a method that produces a fair and reasonable result. This method would be consistent with the approach used to determine GST recovery in respect of other goods and services used to make both taxable and exempt supplies. The fairness and reasonableness of the result would need to be determined with regard to the overall business activity to ensure that, as money is fungible, the costs are not allocated in a way to maximise deductions.

31.Currently, there is potentially a tax preference for businesses to source funding in ways that would enable GST to be recovered. Examples include sourcing funds from offshore or, for businesses that have elected to zero-rate their business-to-business supplies of financial services, from a New Zealand business. Providing the ability to deduct capital raising costs that relate to a business’ taxable activity would help address this bias.

32.This option would reduce compliance costs, as registered businesses that only make taxable supplies will not need to identify and apportion the costs that relate both to raising capital and to their other, taxable, business activities.

33.This option also reduces the potential for tax cascades where GST costs are either absorbed by the business or passed on through the supply chain. This improves the effectiveness of GST as a tax on consumption, rather than on registered businesses.

Option 2: Retain the status quo

34.The status quo potentially creates a disincentive to seeking funding from within New Zealand as businesses issuing securities to domestic investors would be unable to deduct their GST costs, whereas those who are exporting financial services can zero-rate these supplies.

35.This option is associated with greater compliance costs for registered businesses that are raising capital, as the costs associated with raising capital need to be determined and treated differently to other inputs acquired by the business to make taxable supplies. This may result in less certainty as the business is required to determine whether the good or service it has acquired is used for raising capital.